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Is your Family Trust Approaching its 21st Anniversary?
Nick Georgakolpoulos
Insurance & Estate Planning
Over the last few years not much, by way of literature, has been written about Family Trusts.
Family Trusts can be a great vehicle for tax and estate planning because if structured properly they can offer great flexibility, tax deferral, tax minimization and privacy.
Sound too good to be true?
Well, Yes and No!
As with all great planning strategies Canada Revenue Agency (CRA) made sure that a good thing does not last forever.
Most inter-vivos trusts (trusts created during the creator's lifetime), with certain exceptions, are subject to the so-called "21-year deemed disposition" rule. In general, such a rule requires that the trust property be deemed to be disposed of at fair market value every 21 years from the anniversary date of the creation of the trust. To the extent that the trust property has appreciated significantly in value, such a rule can cause significant tax payable by the trust at the top marginal tax rates. (Ontario 46.41%)
The Income Tax Act generally permits a transfer of assets to its beneficiaries to take place on a tax-deferred basis. The beneficiaries are deemed to receive the property at the trust´s cost base and will eventually recognize any income or loss when the property is sold during the beneficiaries´ lifetime or on their death. This distribution planning eliminates a potentially large tax consequence to the trust. Moreover, the tax liability is now deferred to a future date and possibly at lower rates since any income will be taxed at the graduated tax rates applicable to each beneficiary
Accordingly, the 21-year deemed disposition rule can be avoided by the transfer of property to the underlying capital beneficiaries of the trust. A careful review of the trust deed must be done in order to ensure that such planning can be done.
Herein lies the problem, what if the beneficiaries are minors or the only assets inside the trust are shares in a family owned business and the trustee does not feel the capital beneficiaries are ready to receive these assets? What if the beneficiaries are going through marital problems?
There are a few planning opportunities available to ensure that control is still retained by the trustee and at the same time the beneficiaries get what they are entitled to!
The trustee, before the 21st anniversary of the trust, can perform a re-organization of the shares in the family owned business and take back for the trust; shares which have super voting rights and no value. The beneficiaries would in turn, receive, tax-free new common growth shares with limited voting rights.
The trust triggers a deemed disposition at year 21 BUT since the super voting shares have no value there would be no taxes payable.
Dealing with beneficiaries who are going through marital issues is a complicated problem of its own.
A common misconception in the tax and legal community is that if the trust is discretionary in nature, then the trustee can somehow make sure that the spouse of the beneficiary will never get their hands on the trust assets, by not distributing assets from the trust and just paying any taxes that arise in year 21.
The Ontario Supreme Court in Black v. Black dated December 12,1988 (Docket No: D-129698/86) clearly stated that this indeed was not the case. The disgruntled spouse, Conrad Black’s first wife Joanna Hishon was entitled to 50% of the beneficiaries potential trust assets even though the trustees had discretionary powers.
The purpose of this article is not only to talk about what can go wrong but to stress the need to PLAN for all your trust’s 21st anniversary.
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